Fitch Rates Cleveland Muni School District, OH ULTGO Bonds 'AA'

January 04, 2013 02:38 PM Eastern Standard Time

NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned the following program rating to Cleveland
Municipal School District OH's (the district) unlimited tax general
obligation (ULTGO) qualified school improvement refunding bonds:

--$40,395,000, series 2013, 'AA'.

In addition, Fitch assigns an underlying rating of 'A-' to the series
2013 bonds.

The bonds are expected to sell via negotiated sale on Jan. 15, 2013.
Proceeds are being used to refund outstanding series 2004 bonds.

The bonds are voted general obligations of the district secured by the
district's unlimited ad valorem tax pledge.

The Ohio School District Credit Enhancement Program requires the Ohio
Department of Education (ODE) to forward state foundation program
payments to the bond registrar if, prior to the bond payment date, the
district has not transmitted funds sufficient to cover required debt
service payments.

KEY RATING DRIVERS

EDUCATION REFORM LEGISLATION ENACTED: In July 2012, the Governor signed
House Bill 525 known as the 'Cleveland Plan' (the plan). The
legislation's goal is to improve educational standards, and it provides
district management with increased flexibility in working with labor
groups.

PROPERTY TAX LEVY APPROVED: To support the plan, in November 2012,
voters approved, by a strong margin, a new four-year 15 mill property
tax levy.

FINANCIAL PRESSURES EASE TEMPORARILY: The approval of the new tax levy
relieves some budgetary pressures and provides the district with some
financial flexibility. However, Fitch believes that the district will
continue to struggle to build reserve levels to satisfactory levels.

PROACTIVE MANAGEMENT: The district's experienced management team has
taken aggressive steps to address its budget imbalance by successfully
implementing sizeable spending reductions over the last few years.

LARGE AND DIVERSE ECONOMY: Cleveland has successfully diversified its
economy away from manufacturing to the more stable and strong health and
education sectors. Additionally, the area is seeing some momentum due to
several significant projects that are currently in progress.

POOR SOCIOECONOMIC INDICATORS: Despite diversification, the city and the
district continue to experience above average unemployment rates, tax
base declines, poor property tax collection rates and declining
population and enrollment. Income levels are well below average and
poverty levels are more than double the state and nation.

STRONG PROGRAM ESSENTIALS: The bonds qualify for the Ohio School
District Credit Enhancement Program, which is characterized by stringent
requirements and strong program mechanics.

WHAT COULD TRIGGER A RATING ACTION

FAILURE OF CLEVELAND PLAN: Fitch believes the district's inability to
meet specific measurable goals under the plan would most likely result
in failure of voters to renew the property tax levy in four years,
resulting in budgetary pressure and reduced financial flexibility.

INABILITY TO BUILD RESERVE LEVELS: Management's ability to improve
reserves to satisfactory levels in the medium term will be key to
maintaining the rating at the current level.

CREDIT PROFILE

The Cleveland Municipal School District (CMSD) is located in Cuyahoga
County in northeastern Ohio. Of the district's area of approximately 82
square miles, 99.3% is located within the City of Cleveland (the city;
GO bonds rated 'A+' with a Stable Outlook by Fitch). District enrollment
continues to decline due primarily to the declining city population, the
expansion of charter and private schools, and weak academic performance.
Enrollment for 2011-2012 totaled 40,782, a 45% decline since 2000-2001
and a 6.7% decline from 2010-2011.

For the 2011-12 school year, the district was placed in 'Academic
Emergency', a step below the 'Academic Watch' status it held in the
2010-11 school year and the lowest of five possible categories of
academic achievement. Although district performance remained stable, the
value added factor, which is a measure of student learning growth,
resulted in the change in status.

EDUCATION REFORM LEGISLATION RECENTLY ENACTED

On June 12, 2012, the Ohio General Assembly passed legislation and on
July 7, 2012, the Governor signed 'The Cleveland Plan'. The Cleveland
Mayor, Governor Kasich, the General Assembly, the Cleveland Teacher's
Union and the Cleveland business community collaborated to create a plan
for education reform for the district to improve standards, reward,
retain and recruit high-quality educators, increase incentives for
district and charter school partnerships and increase school autonomy
and accountability.

The legislation gives the district greater flexibility and more
authority in how teachers are evaluated and allows the district to
intervene in lower performing schools, reassign teachers and require
them to work more hours, outside of the confines of labor agreements.
Additionally, the district has the legal authority, via agreements, to
share state funds with high quality charter school partners. On an
academic achievement basis, the district will be able to count charter
school student test scores.

The legislation is for six years with the plan being implemented over
four years. The Cleveland Transformation Alliance has been created and
is comprised of members of local government and the community to ensure
accountability for all public schools in the city. The district will
hold itself accountable to specific measurable goals including
eliminating failing schools, increasing graduation rates substantially,
increasing college enrolment moderately, and tripling the number of
students enrolled in high performing schools. Fitch believes that the
goals are somewhat aggressive but this legislation is generally
positive. Combined with the approval of a new property tax levy, it
gives the district some necessary tools for transformation and provides
some financial relief.

NEW PROPERTY TAX LEVY PROVIDES TEMPORARY RELIEF

In November 2012, district voters passed by a strong margin (57%) a
15-mill property tax levy to support the plan and transformation
efforts. The district's existing levy is 64.8 mills. Fourteen mills will
be allocated to the district and one mill will be allocated to the
partnering charter schools (11 currently). Based on reduced 2013
assessed value following a sexennial reassessment and current weak
property tax collections, the levy is expected to generate $63 million
annually for the district. Of this, $4.2 million will be distributed to
charter school partners.

The levy is for four years (through 2016) to provide for accountability,
allowing voters to evaluate whether the district is succeeding and if
tax dollars should continue. In November 2016, a Presidential election
year, the district expects to position the levy as either a renewal of
the 15 mills or a replacement levy, which if assessed values go up,
would allow for an adjusted millage levy and additional dollars.

Fitch views the approval of the tax levy positively despite being
temporary, as it provides financial flexibility and shows strong
community support for transformation. Historically, voter approval for
new property tax levies has not been successful. The last property tax
levy was passed in 1996, with subsequent levies in 2004 and 2005 failing
with 45% and 35% voter approval, respectively.

Bond issues have fared better with all being passed, the last one in
2001. On a positive note, all current property tax revenues, which
represent 23% of total general fund revenue, are derived from
non-expiring levies.

WEAK FINANCIAL PROFILE WITH LOW RESERVE LEVELS

The district's strong and experienced management team has taken
aggressive steps to address its budget imbalance by successfully
implementing sizeable spending reductions including the closing of
schools, the elimination of teaching positions and labor union
concessions. The district closed a $58 million (9.1% of spending) budget
gap in 2011. For fiscal 2011 (year-end June 30), the district reported a
general fund operating surplus after transfers of $37.7 million compared
to a deficit of $37.8 million in 2010. The district reported an
unrestricted general fund balance of $13 million or 2.2% of spending at
June 30, 2011, compared to a negative unreserved (pre-GASB 54) fund
balance of $41 million or negative 6.2% of spending at June 30, 2010.

On an unaudited GAAP basis for 2012 the district recorded a general fund
operating deficit after transfers of $6.4 million due primarily to lower
revenues and higher instruction costs. The unrestricted general fund
balance totaled $10.3 million or a weak 1.6% of spending.

The October 2012 five-year (2013-2017) cash-basis forecast was revised
in December to reflect the passage of the 15 mill property tax levy. The
new levy provides some breathing room with general fund operations
positive through 2014. Deficits of $10.8 million, $23.4 million and $65
million are forecasted for fiscal 2015, 2016 and 2017, respectively.
Fiscal 2017 does not include the renewal/replacement of the 15 mill
levy. For 2013 the general fund ending unencumbered cash balance is
forecast at $41.3 million, up from $35.6 million in 2012 but decreasing
to $11.2 million in 2016 and a negative $53.8 million in 2017.

Fitch recognizes the conservative assumptions of the forecast. However,
while the approval of the new tax levy relieves some budgetary
pressures, Fitch believes that the long-term structural balance and the
building of reserves to stronger levels will remain challenging.
Concerns include the level of future state funding, which represents 69%
of general fund revenues, decreasing assessed value and increasing
property tax delinquencies. Cost containment, successful implementation
of the transformation plan and continued community support remains
essential to the district's financial health.

DIVERSE ECONOMY BUT WEAK SOCIOECONOMIC INDICATORS

While Cleveland's economy has successfully diversified away from
manufacturing to the more stable health and education sectors, the city
continues to feel the effect of the sluggish economy as evidenced by
weak economic trends and indicators. The city continues to lose
population, unemployment rates are above average, poverty rates are more
than double the state and nation, income levels are well below average
and property tax collections remain weak. On the plus side, economic
development is strong with a number of major projects under construction
including the $465 Medical Mart and Convention Center in downtown
Cleveland which is scheduled to open in September 2013.

MANAGEABLE DEBT POSITION

The district's overall debt levels are moderate at 3.8% of market value
or $1,540 per capita, and principal amortization is rapid with 84% of
debt retired in 10 years. Debt service represents a moderate 7% of
general and debt service fund expenditures. Future capital plans are
manageable, with the district contemplating the issuance of $225 million
in bonds in 2014 to fund the remaining three segments of its master
facilities plan. The additional debt would more than double direct debt
levels and will likely slow amortization considerably.

The district contributes to the School Employees Retirement System and
the State Teachers Retirement System, both multiple-employer defined
pension plans. The District is required to make contributions in
accordance with rates established by the state and has annually met the
annual contribution, although this has not always equaled the
actuarially required contribution (ARC). Contributions represented a
moderate 8.2% of unaudited 2012 general fund spending. Total carrying
costs for debt service, pension payment (which moderately underfunds the
ARC) and OPEB costs are manageable at 15.7% of spending.

STRONG PROGRAM ESSENTIALS

The 'AA' program rating is based on the qualification of the series 2013
bonds for participation in the Ohio School District Credit Enhancement
Program. Participation requirements are stringent, including 2.5 times
coverage of maximum annual debt service by unrestricted state foundation
aid on proposed bonds and any outstanding obligations covered by the
program. Fiscal year 2013 estimated state foundation aid to the district
is 14.2 times maximum annual debt service, well above the required 2.5
times.

Program mechanics are strong. Ohio law requires the Ohio Department of
Education (ODE) to forward to a bond paying agent or registrar state
foundation payments otherwise due to a participating school district if,
prior to the bond payment date, the district has not transmitted funds
sufficient to cover a required debt payment. For more information on the
Ohio School District Credit Enhancement Program, see Fitch's report
dated May 13, 2011 at 'www.fitchratings.com'.

Additional information is available at 'www.fitchratings.com'.
The ratings above were solicited by, or on behalf of, the issuer, and
therefore, Fitch has been compensated for the provision of the ratings.

In addition to the sources of information identified in Fitch's
Tax-Supported Rating Criteria, this action was additionally informed by
information from Creditscope, University Financial Associates,
S&P/Case-Shiller Home Price Index, IHS Global Insight, Zillow.com and,
National Association of Realtors.

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